Multiples Have Fallen The 3rd Most In 40 Years

Multiples - Apple & Amazon Fall, But Stocks Rally

The S&P 500 rallied 0.56% on Monday. Berkshire Hathaway’s Class B shares rallied 4.7%. That's because the company bought almost $1 billion of its shares back in August.

In the fist 9 months of the year the firm purchased $24.4 billion worth of shares. That’s over double what the company bought through June. Warren Buffett is widely considered the best investor ever. His buybacks improve investor confidence.

However, investors still aren’t confident in Apple and Amazon. They fell 2.2% and 2.84%, bringing the Nasdaq down 0.38%. Investors are worried about Apple’s iPhone unit growth.

As you can see in the chart below, revenue growth has accelerated while unit growth is barely positive. There’s no way Apple will be able to increase prices on its iPhones at its current rate.

It’s very unusual for a consumer product to successfully raise prices. Just because Apple defied the odds with this cycle of iPhone products, doesn’t mean it can continue to do so.

Multiples - Stocks Are Cheap & There Is Fear

Russell 2000 was down 3 basis points and VIX was up 2.31%. CNN fear and greed index increased from 8 to 9 which is still extreme fear.

It has been in the single digits in this correction for longer than the winter correction. Current forward PE multiple on the S&P 500 is 15.6 That's below the 5 year average of 16.4, but above the 10 year average of 14.5.

As you can see from the chart below, the PE multiple in 2018 has fallen the 3rd most ever as of October 31. Stocks have had a middling performance. Earnings have grown over 20%.

The 3 worst sectors were communication services, technology, and consumer discretionary. They fell 0.32%, 0.18%, and 0.18%, respectively. They were driven down by the big internet names.

Even Facebook fell 1.11% after rallying last week on great earnings. The 2 best sectors were real estate and energy which increased 1.69% and 1.61%.

10 year yield fell 1 basis point to 3.2% and the 2 year yield was flat at 2.91%.

There is now an 81.5% chance of at least one hike by the end of the year. The next Fed meeting is on Thursday. There’s is only a 5.9% chance the Fed hikes rates at that meeting.

Multiples - The Midterm Elections Are Here

It’s important to contextualize stock market data before acting as if elections are all that matters.

Earnings are the most important driver of stocks. Don’t fall prey into thinking the election will tell you where stocks are headed.

On average, stocks rally after the election into the end of the year. I think stocks are severely oversold, so that’s a possibility.

Keep in mind, it’s the oversold nature of the market, not the election that makes me bullish. Another bullish point about the election is there might be gridlock.

As you can see from the chart below, some believe a split government is better than one party majority holding both the Presidency and Congress.

This might happen because the RealClearPolitics average of polls say the Dems will pick up 27 House seats. However, this data would have led you astray in 2017. That had great returns and low volatility even though the GOP controlled the government.

As you can see, utilizing one data point which is tangentially related to stocks won’t bring you alpha.

Multiples - Effect Of Tariffs

Trade war potential is suppressing American soybean exports to China. Soybeans are America’s largest export to China.

As you can see from the chart below, China’s purchases of American soybeans are down 80% in September. And they've been almost non-existent in the past 7 months.

American soybean exports to China usually peak in December. American farmers are getting crushed.

This just adds to the pressure America is under to make a deal with China soon. As you can see, China is replacing American soybeans with Brazilian soybeans. Chinese imports of Brazilian soybeans are up 28% year over year.

The Fed has mentioned the trade war as a negative effect on the economy in its statements. But it hasn’t affected policy because the economy is still strong.

If the Fed were to react to the tariffs before they start hurting the economy, it would help the stock market. That appears unlikely. I’ll be watching the Fed on Thursday to see if it alters this stance.

As you can see from the chart below, trade policy is by far the biggest concern on financial TV news.

Personally, I like to steer clear of the TV news because they sensationalize stories for views. This makes investors more emotional instead of more rational. However, in this case, the financial news is correct to worry about trade policy.

Multiples - Big Key For Workers

The Fed is raising rates because of wage inflation. But it hasn’t translated to price inflation in the past 2 cycles.

The good news for workers is that accelerated nominal wage growth and controlled low inflation means real wage growth is coming. Since the underemployment and unemployment rates are low, this real wage growth is going to many workers.

It doesn’t make sense for the Fed to become hawkish if inflation is at its goal. The Fed is predicting more inflation in 2019. Tariffs put the Fed in a bind because they generate inflation and they slow growth.

Multiples - Conclusion

The S&P 500 rallied slightly on Monday, but it’s still oversold.

With Apple’s decline, the market has lost its top technology leader. I still think stocks can rally without it. But the added concern that tariffs and a hawkish Fed bring make it even more difficult for stocks to break new records. I’m bullish in the short term, because stocks are oversold. However,  in the intermediate term I will stay bearish until the trade war ends.

If it ends, this will be a more normal cycle which eventually ends with the Fed getting too hawkish in a couple years.

 

Spread the love

Comments are closed.